Djerriwarrh Investments Limited (DJW) Earnings Call Transcript & Summary

Hello, and welcome to the Djerriwarrh Half Year Financial Results Briefing. [Operator Instructions] I would now like to hand the presentation over to Mr. Geoff Driver, General Manager, Business Development and Investor Relations at Djerriwarrh Investments. Thank you. Please go ahead.

Good afternoon. As said, my name is Geoff Driver, General Manager, Business Development for Djerriwarrh Investments. Welcome to this half year result briefing. Firstly, I'd like to thank those shareholders who are joining us again after the abandonment of last week's webinar. Thank you for your patience. Unfortunately, the difficulties we experienced last week were well out of our control. And actually, this is the first time it actually has happened in many years doing these briefings with this provider. We are assured it won't happen again. I would like to start the formal part of the presentation by acknowledging the traditional owners and custodians from all the lands we are gathered on today and pay our respects to their elders, both past and present and emerging. I have joining me today on the webinar, Brett McNeill, who's the Portfolio Manager; Olga Kosciuczyk, who's the Assistant Portfolio Manager; Andrew Porter, our CFO; and Matthew Rowe, our Company Secretary. Just to note that Mark Freeman, the CEO of Djerriwarrh, could not join us today, given he has another commitment that could not be changed. Before we start, as we've been reminded, the presentation is available on the website. If you're using the computer to access the presentation via the webcast, the slides will change automatically. If you are accessing by phone, the PDF -- oh, actually, no one is accessing by phone, so that's right. Finally, please note that following the presentation, there will be time for questions and answers. You can ask a question via the webcast. I will now move to Slide 2, which is the disclaimer. And this disclaimer really is just to say that we are not offering personal advice. This is information about the company and how we're managing the company on behalf of our shareholders. So none of the information here should be taken as personal advice for any of those people participating in the webinar. If I go to slide -- next slide, slide -- just an overview of what -- how we'll run today. So I'll give a briefing on the overview and objectives. Andrew Porter, our CFO, will run through the half year in summary. Brett McNeill will cover the results in detail. Both Brett and Olga will give an update on the portfolio, and then Brett will go and discuss the outlook. So if I go to Slide 5. Just a reminder, Djerriwarrh is one of the largest listed investment companies focusing on income in the Australian market. It was established quite some time ago, in 1989, and listed on the ASX in 1995. Shareholders get the full benefit of full transparency associated with being an LIC, as well as high governance standards delivered by an Independent Board of Directors. Shareholders own the management rights of the company. Therefore there's no fee leakage to third parties and no additional fees. What we're basically saying here is no external fund manager running the business, running the portfolio. And so there's no fee leakage like there is across a number of other, I guess, newer LICs in the market, which charge 0.8% to 1% in terms of fees plus performance fees. So the next slide covers the investment objectives. So the 2 main objectives of Djerriwarrh is to provide an enhanced level of fully franked yield, and that's the chart on the left-hand side of the slide. And you can see here that's much higher than what's available from the ASX 200 Index, both in terms of the net asset backing, but also in terms of the share price as well, given the share price is trading at a bit of a discount at the moment. And that gap is about 1.9%. And Brett and Olga will talk a bit later on how that's achieved in terms of the management of the portfolio. The other part of the objective really is to provide capital growth over that longer term. We're not just focused on income. And you can see over that sort of 5 and 10-year period, we have actually delivered capital growth, albeit below the index, but still delivering that capital growth, which is one of the objectives of the company. And again, Brett and Olga will discuss a bit later on how that's been managed in the context of the very strong market that we've been through more recently. If I turn to the next slide, Slide 7. Again, this is just a slide that most shareholders will be familiar with. It's where the share price is trading relative to the net asset backing of the company. And you can see there that, in fact, over 12 months ago, we were trading quite a discount. We managed to pull that back a bit. There's probably a few factors behind that. One is that we've certainly increased the marketing around Djerriwarrh over the last 12 to 18 months. We also bought back some shares at particular times through the market cycle, which I think has also probably helped that to some extent. And the other comment I'd make is that typically, listed investment companies, there's certainly a lot of them trading at discounts at the moment, even across this group. But in very strong markets, what we tend to find is that the LIC share price does tend to trade a little bit below NTA in terms of trying to keep up with the market. But also investors, I think, are more confident in going and investing in their own right in particular stocks and therefore, LICs, traditionally traditional LICs do go out of favor every so often. So with that, I'll hand over to Andrew Porter to discuss the half year in summary. Over to you, Andrew.

Thank you, Geoff, and good afternoon, ladies and gentlemen. So we're on Slide 9, for those of you that are following. And the 4 boxes there, let me just run quickly through them. So net operating result for the half year, $21 million. That excludes the open option positions, and we'll have a look at the breakdown of that result later on with Brett and Olga. So that was slightly down from $21.9 million in 2023. As I'm sure you're all aware, the interim dividend was kept at $0.0725 despite the drop in the net operating result. The management expense ratio, 0.46%, that's $0.46 for every $100 that you have invested in the company. That's still -- we still consider that a very good value. We did say at the AGM that costs were likely to be higher this year. And because this is the costs for the half year over the average portfolio, that is why the MER has gone up. A number of reasons for that. The profit from AICS, which is the service company that employs everybody, Djerriwarrh owns 25% of that. The profit was less this half year than previous years. So that actually impacts the cost of Djerriwarrh. It had a lower refund from AICS this year than it did in the prior years. There are also some one-off costs from share registry transfer. I'm sure you're all aware that the share registry is transferred over to the organization formerly known as Link, and there are some upfront costs associated with that, but it will be cheaper for shareholders going forward once we've got over this hump of the one-off costs. Also, as you have seen, the portfolio remains, and Brett and Olga will talk about this, ungeared at the moment. So the portfolio is less than perhaps it otherwise might have been if it had been fully geared, and that also translates into an MER being higher than perhaps would have been anticipated. The portfolio dividend yield, 6.4% against the market of 4.5% when grossed up for franking and Geoff has been through those figures. Now one quick thing we're often asked about this, what is our franking credit reserves? At the end of June, you'll recall if you read the annual report, that we had $0.204 after the payment of the final dividend because we're paying out slightly less than the net operating result per share, which is just under $0.08, that franking balance has effectively been maintained going forward. So that is at a healthy position. Also for those of you that have seen the accounts, at the moment, we have a tax liability of $5 million, that will also translate into franking credits if and when it is paid to that amount or whatever the amount will be. So with that, I will pass over to Brett. Thank you.

Thanks, Andrew, and good afternoon, everybody. Thanks very much for joining our presentation today. So I'll start on Slide 11, where we present a more detailed run-through of the net operating result that Andrew just touched on. So we show here on Slide 11 how the profit for this period was derived, so a full breakdown as well as how the profit per share flows through to the dividend per share. So we can see how that flows through. And just noting again that the focus here is on the net operating profit being what we think a better measure of Djerriwarrh's operating profit performance as well as the basis for the dividend that we declared. So the overall picture for this half period's result was we had a smaller investment portfolio, which Andrew touched on, and this was given our net cash position that we held during the period. And that led to lower dividend and lower option income, but this was partly offset by higher other income, which was mainly deposit revenue from our cash on deposit as well as lower financing costs. So if we step through the numbers here on Slide 11, you can see dividend and distribution income down 8% to $17.9 million and option income down 21% to $7.5 million. When we include other income, which was mainly the deposit revenue, we saw operating income down 9% to $26.3 million. Working through the costs, finance costs down 71% to $0.8 million from our net cash position and administration cost up 16%, as Andrew mentioned, to $2.1 million. Income tax expense was up 6% to $2.5 million. So at the bottom line, the net operating result was $21 million, down 4% versus the prior corresponding period. And on a per share basis, the net operating result down 5% to $0.0796, with the dividend per share flat at $0.0725 per share. So hopefully, this gives you a better picture of how we derive the profit for this period, but also pointing out that we can see the dividend of $0.0725 is more than covered by the net operating profit result, which we think highlights the sustainability of the dividend. So quite a good position to be in. The next 2 slides give some more detail on the 2 key drivers of our net operating result, which are the dividend and distribution income. This is the income that we receive from the companies we own in the investment portfolio. And then secondly, the option income, which is the income we earn from our option writing activities. Looking at our dividend income on Slide 12. On the left-hand side, we show the dollar amount of dividend and distribution income received over the last 5 half year periods. The right-hand chart shows how this income looks as a percentage of our portfolio size. So that's the green bar, measured against the dividend yield of the share market being the ASX 200, and they're the blue bars. And as we can see, the first half '25 results saw the portfolio's dividend yield well above the market's dividend yield, the ASX 200. And some of the key drivers for our dividend income that we received in the period were from some of our big holdings like Telstra, Transurban, and Woodside, and it was also helped by special dividends from Woolworths and JB Hi-Fi. From here, we expect that the portfolio's dividend yield will be at or slightly above the market level over the long term on average. Slide 13 shows our option income, so a similar type of analysis. The left-hand chart shows the option income that we've earned over the last 5 half year periods. And the right-hand chart shows this option income that measured as the yield of our investment portfolio value. The first half '25 option income yield was about 1.7%. And consistent with how we've described it in recent results, we continue to expect that this option income yield will be around 1.5% to 2% on average in the future, noting that this option income yield is a key part of the overall enhanced dividend yield that we aim to deliver for Djerriwarrh. So we'll now move to the portfolio update section. And here, Olga will give some more detail on some of the key moves in the options portfolio during the period, and she'll also talk through the key changes that we've made to the investment portfolio. And then I'll come back to give a summary of the portfolio and make some comments on the outlook.

Thank you, Brett, and good afternoon, everyone. Our main investment objective is to pay our shareholders an enhanced dividend yield. And to achieve that goal, we generate income by writing call options against select portfolio holdings. On this slide, we show the performance of the market as defined by our benchmark, the ASX 200 Index, overlaid with the top-down view of our portfolio's call option coverage. We started this financial year with call option coverage of 28%, just below the bottom end of our normal range of 30% to 40%. We increased the coverage to 34% in early August in response to the ASX 200 Index rising above 8,100 points. And as the market continued to perform strongly during the half, we maintained high portfolio option coverage, between 40% and 45%. This saw us generate a good level of option income, but it weighed on our performance given reduced exposure to equities, especially in major banks and JB Hi-Fi, which we had significant option exercises in. We finished the calendar year with call option coverage of 41% and entered the second half with a good amount of option premium in the book. On Slide 16, we show our key recent transactions. We had significant option exercises across banks, Commonwealth Bank, NAB, Westpac, and Macquarie Bank as well as JB Hi-Fi. We consider these companies to be high quality, but expensive in terms of valuation. As such, we chose not to buy these stocks back following the option exercise. As a result, our combined holding across these companies reduced from around $250 million 12 months ago to just $60 million at the end of the first half of financial year 2025. We also were exercising calls, but chose to buy the holding back. We were also active sellers of our small remaining holdings in Ramsay Health Care and FINEOS, both of which have been disappointing investments for us. And finally, during that period, we sold out of Mineral Resources. We were extremely disappointed in the company's corporate governance practices, which saw us lose confidence in this investment. And as a result, we decided to exit the position. We reinvested the capital realized from these sales in what we consider to be high-quality companies trading at attractive prices. We also retained some cash for future opportunities given our view that the market is looking expensive. Our largest purchases for the first half of this financial year were 2 large diversified miners, Rio Tinto and BHP. We consider them to have high-quality assets, management, and strong balance sheet. Both companies have been mainstays of the portfolio for a long time, but we increased our holding substantially given both companies are trading at attractive valuations on the back of the market's concern about iron ore demand supply dynamics, given slowing economic growth in China, the key importer of iron ore. We believe that these risks are reflected at those prices and know that both companies offer above market fully franked dividends yields of around 8%. We also added to our holdings in supermarkets, Woolworths and Coles, as they face intense regulatory and media scrutiny during the year, providing us with opportunities to add to our holding at attractive valuations, which, in our view, underappreciate the quality of these companies, especially the defensive nature of their earnings. We also increased our exposure to gold by our holding in Newmont Corporation. And finally, we added one new holding during the period, Ampol, which was formerly known as Caltex. Ampol is Australia's leading vertically integrated energy company. It operates businesses across convenience retail in Australia and New Zealand as well as the refining, supply, and marketing of fuel. We believe that Ampol is a better business today compared to 5 years ago. The earnings mix is better. The balance sheet is solid. The quality of the network has improved and management have demonstrated good capital allocation and discipline. Ampol primarily offers our portfolio an attractive level of dividend income, especially if trading conditions in the refining business improve from the current cyclically low levels.

Thanks, Olga. So turning to Slide 17, and we show here a summary of the Djerriwarrh portfolio, starting with some key metrics on the left-hand side as of the end of the period, so end of December 2024. We can see the portfolio's value was $860 million across 45 stocks owned. Call option exposure, as Olga mentioned, finished the period at 41% and minimal put option exposure of 0.5%. And so this added up to a net tangible asset backing per share of $3.39. And as Geoff mentioned at the start, the share price still trades at a discount, albeit a reduced discount to that $3.39 per share NTA value. On the right-hand side of Slide 17, we show the top 20 holdings in Djerriwarrh, starting with BHP, the largest holding in the portfolio by value. You can see here the impact of the portfolio changes that Olga just discussed, particularly there's no Commonwealth Bank, Westpac, or JB Hi-Fi in our top 20 anymore, whereas they previously were particularly big holdings 12 and 18 months ago. And even stocks that we still own, our core holdings, I guess, for Djerriwarrh like Wesfarmers, Macquarie Group, National Australia Bank, they're in the top 20, but they're much lower down in terms of the size than they were 12 and 18 months ago. Overall, though, we think the portfolio has got the right balance of income and growth for this point in time. And particularly, we see it as defensively positioned. So from that portfolio summary to some outlook comments that we list on Slide 19. And the backdrop is, as we enter calendar year 2025 that we think the equity markets has had a very good run. So 2024 was another strong year for the ASX 200, but we think it leaves the market looking expensive to us, particularly when we look at how the market is trading at the moment versus long-term averages, so 10 years plus on some key fundamental valuation metrics like price earnings ratio, price-to-book ratio, and especially important for Djerriwarrh, the dividend yield of the market being very low at the moment at about 3.5%. So based on that sort of top-down view, particularly combined with our bottom-up analysis and stock views, we're conservatively positioned at the moment. That's the main thing we'd highlight today. We're conservatively positioned, and you can see that in our higher-than-average call option coverage across the portfolio of 41%, and we've got a net cash position. So we think that gives us the potential to take advantage of some good investment opportunities should they present at some point in the near future. So that's overall our view on markets and how we're positioned. If we look at the 2 key drivers of our profit and by extension, the dividend that we pay, which is really our dividend income and our option income, you can see in terms of the dividend income, the portfolio changes that we talked through mean that we're a lot more reliant on the top companies listed on Slide 17 now for our dividend income, particularly large resource stocks like BHP, Rio and Woodside; the supermarkets, Coles and Woolworths as well as stocks that we classify as high-quality defensive [ store ] type companies like Transurban, Telstra, and Region Property Group. And then on the other side, we're significantly less reliant on the banks for our dividend income at this point. In terms of our option income, it's a key part of our enhanced yield and the option book is in good shape. We've got a good amount of option income already written for second half '25 that's not recognized as profit yet. And we've got the flexibility to write more option income, particularly in the latter part of the second half period. So overall, when we think about how we're positioned and the outlook for dividend and option income, we're confident in our ability to deliver on the income and growth objectives for Djerriwarrh. And I'd just reiterate, we're conservatively positioned given current market levels, but still well placed heading into second half of financial year 2025. So with that, I'll hand back to Geoff to take some questions.

Thank you, Brett.

And just to remind people, you can ask a question via webcast at the bottom of the screen. The first question I've got is about the banks. And you talked about being underweight to banks given the exercise in options. What's the catalyst for you to actually start thinking about reentering that part of the -- that sector of the market?

Sure. Yes. It's valuation driven because we don't have a problem with the quality. And if we go back 2 years ago, when we were big buyers of the banks, we were very confident in the quality of the banks being things like the balance sheet, the management teams, the Boards that were there, the dividend payout ratios and the like. So we thought the quality was really strong. But back then 2 years ago, the valuations were very attractive to us. Sentiment towards the banks was terrible. We go back -- it was only under 2 years ago that there was a banking crisis in the U.S. with Silicon Valley Bank going bankrupt and First Republic, and that sentiment flowed on into our banks, and they were trading very cheaply as a result. So we were big buyers then. Fast forward to today, in the last 6 months, we've been the other way. We've been big sellers, as Olga mentioned, through option exercises, through the call options we had written against our bank holdings. And we're comfortable owning a lot less of them today, it feels right. So the catalyst to get back in would really be valuation. We're not looking for any major kind of improvements in the quality. We think they're well managed. They're doing a good job, but the valuations have just gone really well through now what we consider to be reasonable. And I mean, to put some numbers on that, just comparing like we do because we're able to invest across the whole market. If you look at dividend yields on a -- so grossed up for franking credit. So fully franked dividend yield, Commonwealth Bank is only 4.5% today. And some of the stocks we've been buying and that we're more relying on for our dividend income today like BHP, Rio, Woodside, Telstra trade on fully franked dividend yields of over 7%. It's a big difference, and we think the quality of those stocks is very good as well. So it'd be valuation, Geoff.

Thank you, Brett. What were the disappointments that brought about the sale of Ramsay Health Care and FINEOS? And what would cause you to consider buying either company again?

Yes, sure. I mean, yes, buying them again is not on the radar so much at the moment, but we're always happy to revisit things down the track if they change. But we always try and buy things for long term, obviously, and ideally be buy and hold. But you've always got to revisit things on the way through because clearly, not everything works out, same for any investor in the market. And it just makes sense to chop a bit of wood as you go. And with these 2 stocks, they've been poor performers for us. That in itself is not the catalyst to sell something. Obviously, you can't just sell something because the share price has gone down. It might be temporary. But with Ramsay, we gave it a lot of time. And it's got a lot of quality attributes, but the industry is extremely tough for them at the moment with the profitability of private hospitals, combined with some pretty average returns from the overseas investments that they've made. So at the end of the day, we looked at that, and we can see potential for the returns to improve. But really, we always look at what does it offer this portfolio? And broadly, it's got to be growth or income. And it's not a high-growth stock, albeit the potential to turn around, but we weren't getting rewarded with income on the way through either, a low yield. So we thought it made sense to call time on that one and move it on. And with FINEOS, that one was really a mistake. We went into that at the wrong time and whilst it had a lot of positive attributes being aligned management team, so the founder, Michael Kelly, and an attractive long-term thematic with the product that they sell being software to insurance companies, it was very slow going, and they still weren't profitable at the bottom line. So -- and clearly a long way away from paying a dividend. And it made sense for us just to, frankly, that one, revisit it. And again, it didn't offer growth or income, and we thought the potential for it, whilst it might still be there, was going to take too long to realize. So often in those cases, it's better to cut the losses and move on, which is what we did for both of those.

The previous presentation or presentations, I should say, it was mentioned that Djerriwarrh had adjusted the way it invests about 3 years ago and has been happy with how things have gone in the past 3 years. Can you give us an overview of what, I guess, the strategic adjustments were and what the change in thinking was back then?

Yes, certainly. And yes, firstly, we are happy with how it's gone. So it was never going to be a turnaround with short-term benefits. We want to build something that produces a really good long-term track record and reward the investors for being in. We think the premise for Djerriwarrh was always really strong. The enhanced yield component is a unique offering in this market, particularly when you can get it from an LIC that has a low management fee. So those characteristics you touched on, Geoff, about no fee leakage and the like. So you get scale benefits over time. It all accrues to the investors. So low MER, so it's the right structure. The enhanced yield is very attractive, but it's getting that balance of income and growth right. So that's, in a nutshell, the main thing that Olga and I have tried to change since we took over management of the portfolio with the backing of the broader group. And we are happy how it's gone. So we've delivered a very good level of enhanced yield. We think it's been done in a sustainable manner, and that's a key point that we always want to reiterate. So while we give that breakdown on the profit and loss, you can see that the dividend per share is more than covered by the net operating profit per share. So we've delivered sustainable enhanced yield. The dividend has grown over the time since we've done the strategy reset. It won't grow every single 6-month period, like it was flat in this one, but it has grown on a yearly basis since then. And the capital growth has been okay, but we think we can do better on that. And we can see from the performance slide earlier on that the total return of the portfolio, and of course, it's net of fees -- sorry, net of costs and taxes has lagged the market in a strong market. But we'd argue that that's because of the conservative positioning of the portfolio at the moment as opposed to any other sort of structural issues or the like. And that's a position that we've chosen to be in at the moment to be defensively positioned. It's how we see the markets, both top down and bottom up. And we think it's a good position for Djerriwarrh to be in at the moment. So overall, we're definitely happy with how it's gone. But at the same time, we know we've got a lot still to deliver on and to keep proving up because it's -- we're here to do it for the long term, not just a short-term turnaround.

Thanks, Brett. I guess it's a much more sustainable footing we're on now than we were, say, 5 years ago.

Yes.

Too high, [ hang out ] with large amounts of realized capital gains. Just a reminder, to ask a question via the webcast, you can ask at the bottom of the screen. Will you introduce Sigma Healthcare post-merger with Chemist Warehouse into the Djerriwarrh portfolio?

Yes. Thanks, Geoff, for the question. So last year, ACCC approved the merger between Sigma and Chemist Warehouse and it's expected to finalize next month. So Chemist Warehouse really doesn't need any introduction. It's a world-class retailer. It operates in a high-growth, low cyclicality sector. It has high barriers to entry. So it really translates to very healthy cash flow and strong resilient revenue growth, which we think can be double digit over the next few years. And this is further supported by an opportunity to further roll out stores here in Australia, but also abroad. So we think it could translate to a strong dividend yield. So it certainly ticks a lot of boxes for us. It's a high-quality business. I think the only -- so that means that it's firmly on our watch list. The only thing that really stops us from buying it straightaway is the valuation. It's currently trading at almost 65x price to earnings, which is a very hefty valuation, but it's something that's on our watch list, and we'll continue to monitor it.